April 1, 2013

“Volatility To Come Back For Extended Periods” – Barron’s, March 22 

“Stock Market Volatility In April Coming, Here’s Why” – Forbes, March 26

Open the business section or visit the website of your favorite news publication and you will see headlines focusing on short-term events and volatility.   When it comes to investing it is little surprise that people are conditioned to associate short-term volatility with risk.

A common solution that we have seen suggested by financial advisors is to switch your investments from stocks into private investments like real estate or infrastructure funds.  This strategy tends to calm nervous investors because private investments are usually less volatile than stocks. This thinking is silly. The reason private investments are less volatile is because they are priced infrequently. The underlying risk of an investment has nothing to do with how often it is priced.  Similarly, a roller coaster ride might feel less scary when you close your eyes, but it is no less risky.

Let’s look at the example of Suncor, the largest energy company in Canada. If you owned the stock throughout 2012 (we didn’t), you made about 13%. If you looked at the stock price daily, the high occurred at $36.23 and the low occurred at $26.94, a difference of more than $9 per share. But if you only looked at the stock price quarterly – the end of March, June, September and December – then your ride was a lot smoother.  The high was just $32.57 (lower than $36.23) and the low was only $29.08 (higher than $26.94) for a range of just $3.50 per share. Restraining yourself from checking stock prices every day will reduce the volatility you experience but it won’t change your return nor will it change your risk because in both cases you own the exact same business.

It would be nice if stock prices ticked up a little bit every day but the world does not work that way.  If you want to minimize volatility, we recommend checking prices less frequently. But if you want to minimize risk you should invest in a portfolio of unrelated, understandable companies, pay appropriate prices and avoid leverage. This describes our approach at Ewing Morris.

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